Risk/Reward Vol. 168
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Cause you're fallible/Yeah, you're fallible
And we hold up a mirror/And we hate what we see."---lyrics from "Fallible" by Blues Traveler
"Oh the reflex, what a game/He's hiding all the cards
The reflex is in charge/Of finding treasure in the dark."---lyrics from "The Reflex" by Duran Duran
"Yeah, Rwanda, Rwanda
They said 'Many are called and few are chosen.'
But I wish some wasn't chosen."---lyrics from "A Million Voices" (from the "Hotel Rwanda" soundtrack) by Wyclef Jean
In conservative circles, it is an article of faith to believe that billionaire George Soros is a meddling, left wing crackpot and a failed philosopher. Conservatives "hate what they see.". Having recently read his book, "The Crash of 2008", I concur: 1) that Soros is a philosopher, but his success or failure has yet to be determined; 2) that he is a meddler who believes that because humans are "fallible", regulation is necessary; and 3) that he is most certainly a billionaire---many times over. But a crackpot, he is not. In his book (which is more a philosophical tract than a history), he asserts that "cause you're fallible", the application of scientific principles to human endeavors, especially economics, is fallacious. Accordingly, he rejects economic principles such as the efficient market hypothesis ("EMH"), equilibrium and market fundamentalism. Since each can be manipulated, he reasons, none can be a principle.
If one agrees, one should consider Soros' central thesis---reflexivity: the notion that since humans are fallible, human institutions like stock markets can be and often are "gamed" by those "in charge" who wittingly or otherwise "hide all the cards." Since they are reflexive, markets, contrary to conventional wisdom, are not inherently efficient. They are just as likely to create bubbles as they are to find equilibrium. As demonstrated by his own successes, Soros believes that one can reap rewards far in excess of the mean without accepting above average risk. He looks for asset bubbles, rides them for a while, exits them in time---and then, bets against them as they burst. Soros has made billions in doing so, most notably on his famous bet against the British pound and most recently on his bet against the yen.
Soros, along with a host of other market mavens (e.g. El-Erian, Druckenmiller, Dalio, Zell) believes that currently, the world is in the midst of a massive and unprecedented asset bubble created by central bankers who through quantitative easing (QE) have forced investors into progressively risky assets by keeping investment grade returns near zero. C'mon folks, does anyone reading this email doubt that today's stock and bond markets are bubbles? Do the past performances and future prospects of the underlying companies warrant all time high stock valuations? Has the risk profile of Spain with its record high 27% unemployment rate really improved so dramatically as to warrant its 10 year bonds yielding a mere 4% when just last summer they yielded over 7%? Absolutely not! Forget Lebron James, start collecting the bobbleheads (rather, bubbleheads) of Mario Draghi, Ben Bernanke and other central bankers..
Clearly QE and the search for yield have led many to make risky investments : ones they "will wish weren't chosen." A case in point is this week's sale of $400million worth of 10 year Rwanda bonds. "Yeah, Rwanda, Rwanda"---you remember, the genocidal nation featured in the movie "Hotel Rwanda". That bond issue was oversubscribed and the bidding drove the bonds down to a 6.625% interest rate---roughly the same yield one would get from the tax advantaged preferred shares of an A rated insurance company or of the Royal Bank of Scotland. But is this irrational? No. With central banks buying the lion's share of developed country bonds via QE, there are fewer bonds available and those that are pay a paltry yield. Bond funds (even ones you hold) and pension managers are awash in cash which they need to invest at some return. Literally there is a scarcity of product so when any new bonds are issued they are snapped up----even 10 year Rwanda bonds. You think not? Next quarter, check the SEC filings that list the holdings of any international bond fund you hold .
Recognition of this bubble notwithstanding, is it time to liquidate? I say no. With the rest of the world in even worse shape, U.S. debt and equities continue to be in demand. Indeed, it was reported on Tuesday that foreign investment in U.S. securities is at an all time high. This demand continues to drive prices higher in what PIMCO's CEO Mohamed El-Erian terms "the most unloved rally" of all time. Just look at what happened this week. Buoyed by Thursday's interest rate reduction in Europe and Friday's marginally improved U.S. job numbers report, both the Dow Jones Industrial Average and the S&P 500 set new records at the close on Friday. In addition, junk bonds are at historic high prices (and thus historic low yields). The bubble continues to inflate. So long as central banks keep printing money and keep inflating assets, I will continue to be in the market knowing full well that once these banks signal that the printing presses are slowing, the 'unloved rally" will end quickly---and badly. For now, that risk be damned. Yield hunters like Duran Duran and me are still
"Hungry, hungry like the wolf."
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